Be choosy about international stock funds in 2013

Constraints on growth could limit global markets’ return

By

RachelKoning Beals

CHICAGO (MarketWatch) – International-stock mutual fund investors went on holiday in 2012, basking in sunny gains that even surpassed a strong year for U.S. equities.

Analysts lean toward cyclical growth-stocks over traditionally defensive shares for 2013, much as they did in 2012. But they’ll be choosier, considering these markets’ rich valuations. The short list includes select European financial shares, as well as Japanese exporters should predictions for a weaker yen come true.

“International equities look to be a pretty good place to be 2013,” said Martin Jansen, senior portfolio manager at ING U.S. Investment Management, where he steers the ING International Value Fund
US:NIVAX
which gained 13.4% in 2012. “U.S. assets are priced at significant premiums and while we see continued recovery there, it’s now the story of markets that got left behind. And that’s Japan and parts of Europe.”

Money-market funds have too much baggage

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Low yields and talk of further regulation have steered some financial advisers away from money funds.

Broad international-stock mutual funds and exchange-traded funds both rose more than 17% on average in 2012, according to preliminary data from investment researcher Morningstar Inc. Funds invested in diversified emerging markets specifically gained 18% on average.

Yet another year of strong performance for international funds is far from certain, especially at these lofty valuations, managers caution. Europe scrambled throughout 2012 to shore up its fiscal foundation, which is still shaky.

“2012 was a strong year for stocks despite the macro gloom we’ve been steeped in. Stocks went up quite a bit in the face of the ‘fiscal cliff,’ Europe’s near currency crisis, and the terrible fiscal position of major developed economies. But nothing structurally has changed,” cautioned Daniel O’Keefe, co-manager of Artisan International Value
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and Artisan Global Value
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funds, which finished 2012 up 22.8% and 19%, respectively.

For now, a therapeutic 2012 helped international funds reclaim a significant piece of a poor five-year performance. Almost every foreign stock-fund category Morningstar tracks delivered double-digit returns, with the exception of Japan and Latin America.

Foreign Small/Mid Growth funds, for example, added 22.2% for the year on the back of a 4.8% fourth-quarter gain. Foreign Large Blend funds, meanwhile, gained 18.2%; a 6.5% advance in the final quarter boosted that result. The best single-country fund performance in 2012 goes to India, up 29.6%. Pacific/Asia ex-Japan funds rose 22.6% on average to take the top spot among regional funds.

As the data show, international investors wanted to buy. And buy they did, even as policy struggles ensued in the U.S. and Europe.

Europe responds

Desperate times called for aggressive if controversial action by the European Central Bank in 2012. The ECB delivered and stock markets responded.

The euro zone is now largely operating under a tightened fiscal belt, while the ECB and European Union heads have committed to preserving the shared currency. New ECB head Mario Draghi criticized political leaders and emerged from a June summit with stronger backing to address regional financial woes. He also called then for centralized banking regulation and in December, the European Union gave the ECB greater oversight over large banks. In September, the ECB pledged to buy the bonds of the most indebted members in order to support the euro. As for interest rates, by year end, they stood at a record-low 0.75%. Read more: Yield to global, short-term bond funds in 2013.

Challenges remain, but Europe appears to have cleared its biggest liquidity danger. The MSCI Europe ex-U.K. Index, a proxy for the euro zone, rose 19% for the year through the third week of December. Germany’s broad DAX Index was up 29%, on track for its best annual performance in nine years. Commerzbank, Germany’s second-largest bank, says in a commentary that it expects the DAX to gain 11% in 2013.

European stock funds gained 21% on average in 2012, according to Morningstar, helped by a 6.9% advance in the final three months of the year.

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